by Nelson Garcia on July 2, 2014 – The Realnovator

 

American’s today feel differently about pot than they did twenty, ten, even one year ago.

In two U.S. states — Washington and Colorado — marijuana is now legal for recreational use, driving the debate about how it should best be regulated, consumed and taxed as it gains acceptance across the U.S. and in other countries. These states’ decisions are also contrary to federal statues, hence marijuana still being illegal in the Fed’s eyes.

U.S. policy is also finally acknowledging that hemp, a cannabis plant related to marijuana but lacking the THC chemical that makes marijuana users high, can help restore our agricultural economy. Industrial hemp is harvested in other countries for its versatile use in food products, textiles and building and construction materials. It also takes half the water that wheat does, and provides four times the income. A provision in the 2014 farm bill signed by President Obama on Feb. 7 allowed for the establishment of pilot growing programs.

This generational shift, which is also driving acceptance of other trends like same-sex marriage, is causing a domino effect and forcing legislative change faster than had previously been imagined.

So what does it have to do with real estate?

First, it’s big business. The cannabis industry could generate about $20 billion a year, or more, if it was legal nationally, according to Jeffrey Miron, an economics professor at Harvard University. Many believe that the most promising and overlooked opportunities will be in ancillary businesses, commercial real estate being one. “Most of the guys digging the gold ore in the gold rush didn’t make much money but the vendors selling picks and shovels made a killing.”

So before one gets to enjoy the devil’s lettuce, it needs to be cultivated and grown (generally indoors for reasons of quality and state laws), packaged, distributed and sold. This requires land and warehouse space (cultivation & production facilities), retail space to sell it (dispensaries) and office space to manage it (corporate offices, testing labs, etc.). Grow facilities range anywhere from a couple of thousand square feet, up to 50,000 square feet. Retail dispensaries typically lease between 1,000 and 3,000 square feet (think size of today’s e-cig stores).

Then you also have the benefit of “marijuana tourism” driving significant hotel demand to these first-to-legalize cities. Coinciding with the legalization of recreational marijuana, Denver hotel occupancies and average daily room rates have climbed to all-time peaks. Growth rates experienced are comparable to what metros see when they host the Super Bowl or the Republican or Democratic national conventions. Evidently the most irregular jump in demand is coming from states with the strictest drug laws in the country.

So you have an entirely new demand driver being created for various types of properties in places where legalization of marijuana occurs.

High Times in Colorado

Colorado in particular has been a great test bed for legalization of marijuana and a preview of what’s in store for the rest of the country when inevitable country-wide legalization occurs.

In Denver for example, the theme seems to be “you can’t grow the stuff fast enough”. The legalization of marijuana has created a boom, so much so that some recreational stores have been forced to curtail sales because strong demand from customers has outpaced supply. Marijuana for recreational use also appears to be a net positive for real estate, not only for industrial space but for retail and office space as well according to Todd Davis, with Cassidy Turley’s San Diego office.

In fact, there’s actually a shortage of warehouses in Denver’s industrial real estate market. Denver’s industrial vacancy rate of 3.1 percent is abnormally low — the lowest in decades, according to brokerage firm Colliers International.

Commercial real estate tracker Xceligent Inc. estimates that marijuana cultivation and manufacturing facilities in the city occupy about 4.5 million square feet — the equivalent of 78 football fields.

Where’s the financing?

Capital in the industry often comes in the form of cash. A marijuana-related tenant’s credit is sometimes a duffel bag full of $100 bills.

Marijuana’s illegal status under federal law means banks cannot take deposits, nor lend money to marijuana-related businesses as most are regulated by federal laws and can face harsh penalty and even loss of charter. Insurance companies and institutional investors remain wary of participating, while there are cases of CMBS loans secured by retail containing marijuana-related tenants.

Some banks such as Wells Fargo have forced landlords to drop marijuana-related tenants in order to keep a loan, while others have even begun moving immediately to eviction or simply calling the note.

In step the opportunistic lenders.

Private equity backed lenders, like Montegra Capital Resources, have heeded the call and begun offering short-term, high interest rate loans to properties occupied by marijuana-related tenants. These loans are bridges to the hopeful event that federal regulators come around and allow the industry to access banking services like any other business.

Earlier this year the Feds gave guidance for banks on how to deal with marijuana focused businesses, though operators continue to have a difficult time opening bank accounts and establishing lines of credit. Industry experts claim that the only real solution is an act of Congress, which isn’t likely in the near future.

“Put simply: Banks need the permanence of law versus changeable guidance,” said Colorado Bankers Association president and CEO Don Childears.

Until then, there’s a major opportunity for bold entrepreneurs and institutions that are willing to provide financing to this industry so long as they do their homework and are comfortable with the risks involved.

Still, not many landlords are cool with the reefer

Since federal law makes it impossible to obtain financing, many cannabis operations can’t afford to purchase land outright and are either forced into risky and unattractive leases, or face tying up capital in real estate and having working capital shortages that can inhibit their ability to capitalize on the industry’s rapid growth rates.

As a landlord, even if I was the biggest advocate for the legalization of marijuana, I’d still have a business to run and would have to acknowledge certain potential issues if considering a marijuana-related business as a tenant. These include anything from being at risk of federal forfeiture, concerns of impact to other tenants and putting me in violation of requirements under deposit and loan agreements, or losing my credit facility with the bank.

Landlords who are taking on these types of tenants are the minority and will continue to be until Uncle Sam makes them all comfortable at the federal level. Those that are accepting the risk are reaping the rewards, but also taking proper precaution such as inserting special provisions in lease agreements like 30-day lease termination notices and stringent operational and signage restrictions.

Opportunity knocks but once

A handful of landlords with an appetite for risk are capitalizing on the supply/demand imbalance in these markets by charging premium lease rates. Industrial brokers report instances of warehouse space leasing for as much as four times the prices paid before medical marijuana sales began to boom in 2009.

It’s no surprise that marijuana related tenants can afford to pay these steep premiums though if you look at the economics and margins of the business.

Growers are paying between $450 and $1,100 a pound (about 4 to 8 plants worth) to grow all in and selling that wholesale for $3,000 to $4,000 a pound and retail for $11,000 a pound. Colorado has approved licenses for almost 200 stores and more than 50 grow facilities housing businesses, and the pace of these approvals dictates the supply/demand dynamics.

The companies playing in the marijuana-landlord sector include Advanced Cannabis Solutions, Zoned Properties, and Cannabis-RX Inc., among others, all mainly specializing in finding warehouse space for cannabis cultivation and some providing other services such as financing.

Cannabis-RX Inc. for example owns almost 40 properties in states including Washington and California and has raised $30 million in capital with plans to invest in light industrial and commercial properties suited for the needs of dispensaries, medical clinics, growers, and those who may supply products and services to the cannabis industry. Cannabis-RX’s CEO Llorn Kylo, said the company has achieved an average internal rate of return of about 32 percent per property.

These investors usually upgrade the properties for growing purposes. The buildings need more amperage than typical warehouses, special air conditioning and ventilation systems, and the interiors have to block all daylight so growing cycles aren’t disrupted.

Many times it also creates the opportunity to fill buildings that may be obsolete for traditional uses like distribution, in turn filling a void in the market.

On the retail side of things, dispensaries are facing scarcity issues themselves, which certain zoning restrictions are also amplifying. But if you’re a retail landlord and having trouble filling small shop vacancy, there’s plenty of demand in the pipeline. An example: Seattle-based businessman and former Mircosoft executive Jamen Shively plans to invest $100 million over the next three years in the nation’s first chain of marijuana stores, which will sell cannabis for both medical and recreational purposes in Washington, California and Colorado.

Final Thoughts

Like with technological innovation, it’s generally difficult for governments to ignore popular demand, whether it’s Uber or Mary Jane. And with any new industry, especially one riddled with this much legal uncertainty, the majority of people will take a wait and see approach. Some will tip toe their way into the opportunity and a handful of innovators will smash straight through with a Kool-Aid Man-like entrance.

Only time will tell when it is in every state that you’ll be able to grab an 8 ounce Frappuccino at Starbucks and walk to the shop next door for a one ounce servcing of ‘super silver sour diesel’. Whenever that time comes, you can be sure that these legitimate businesses will fuel economic growth, local real estate markets, and be run like any other institution with a seasoned CEO at its helm, perhaps wearing a Hermès tie patterned with a familiar green leaf.